Bond Pricing and Yield Curve Modeling A Structural Approach

In this book, well-known expert Riccardo Rebonato provides the theoretical foundations (no-arbitrage, convexity, expectations, risk premia) needed for the affine modeling of the government bond markets. He presents and critically discusses the wealth of empirical findings that have appeared in the literature of the last decade, and introduces the 'structural' models that are used by central banks, institutional investors, sovereign wealth funds, academics, and advanced practitioners to model the yield curve, to answer policy questions, to estimate the magnitude of the risk premium, to gauge market expectations, and to assess investment opportunities. Rebonato weaves precise theory with up-to-date empirical evidence to build, with the minimum mathematical sophistication required for the task, a critical understanding of what drives the government bond market.

Part I. The Foundations: 1. What this book is about; 2. Definitions, notation, and a few mathematical results; 3. Links between models, monetary policy, and the macroeconomy; 4. Bonds: their risks and their compensations; 5. The risk factors in action; 6. Principal components: theory; 7. Principal components: empirical results; Part II. The Building Blocks – A First Look: 8. A preview – a first look at the Vasicek model; 9. Expectations; 10. Convexity – a first look; Part III. No Arbitrage: 11. No arbitrage in discrete time; 12. No arbitrage in continuous time; 13. No arbitrage with state price deflators; 14. No-arbitrage conditions for real bonds; 15. The links with an economics-based description of rates; Part IV. Solving the Models: 16. Solving affine models: the Vasicek case; 17. First extensions; 18. A general pricing framework; 19. The shadow rate: dealing with a near-zero lower bound; Part V. The Value of Convexity: 20. The value of convexity; 21. A model-independent approach to valuing convexity; 22. Convexity: empirical results; Part VI. Excess Returns: 23. Excess returns: setting the scene; 24. Risk premia, the market price of risk, and expected excess returns; 25. Excess returns: empirical results; 26. Excess returns: the recent literature – I; 27. Excess returns: the recent literature – II; 28. Why is the slope a good predictor?; 29. The spanning problem revisited; Part VII. What the Models Tell Us: 30. The doubly-mean-reverting Vasicek model; 31. Real yields, nominal yields, and inflation: the D'Amico–Kim–Wei model; 32. From snapshots to structural models: the Diebold and Rudebush approach; 33. Principal components as state variables of affine models: the PCA affine approach; 34. Generalizations: the ACM model; 35. An affine, stochastic-market-price-of-risk model; 36. Conclusions; 37. References.

Rebonato provides an authoritative, clear, and up-to-date explanation of the cutting-edge innovations in affine modeling for government bonds, and provides readers with the precise tools to develop their own models. This book combines precise theory with up-to-date empirical evidence to build, with the minimum mathematical sophistication required for the task, a critical understanding of what drives the government bond market.

Riccardo Rebonato is Professor of Finance at EDHEC Business School, France. He has been Global Head of Fixed Income and FX Analytics at Pacific Investment Management Company, LLC (PIMCO), and Head of Research, Risk Management and Derivatives Trading at several major international banks. He has previously held academic positions at Imperial College of Science, Technology and Medicine, University of London and University of Oxford, and has been a Board Director for the International Swaps and Derivatives Association (ISDA). He currently is a Professorial Visiting Fellow at the University of Edinburgh, and sits on the Board of Global Association of Risk Professionals (GARP). He is the author of several books and articles in finance and risk management, including Portfolio Management under Stress (Cambridge, 2014).